Warren Buffett probably liked Occidental Petroleum's second-quarter earnings report.
Occidental Petroleum (ticker: OXY), in which Buffett's Berkshire Hathaway (BRK/A, BRK/B) is the largest shareholder, topped profit estimates, paid down nearly $5 billion in debt and is now set to return more cash to shareholders.
Occidental shares were 0.9% higher in premarket trading to $65.66.
Occidental bought back $1.1 billion of stock through Aug. 1 with about half that total coming in July and half in the second quarter. Berkshire's holding of 181.7 million Occidental shares represented a 19.5% stake at the end of June. Occidental earned an adjusted $3.16 a share in the second quarter, above the consensus estimate of $3.03 a share and up sharply from 32 cents in the year-earlier period.
Berkshire's stake should hit 20% in the coming months as Occidental completes a $3 billion buyback program. A 20% stake would allow Berkshire to include in its earnings a proportionate share of Occidental's profits. That would boost Berkshire's reported earnings by about $2 billion although there wouldn't be much cash associated with those earnings.
"Oxy is killing it in growing book value per share," says Cole Smead, co-manager of the Smead Value fund, an Occidental holder. "Where else can you find a company growing book value as quickly." He calculates that Occidental grew its net worth per share by about 11% in the period while earning outsize returns on equity.
Occidental's strategy over recent quarters has been to use its ample free cash flow to pay down debt, which totaled $21.7 billion on June 30, and effectively transfer wealth to shareholders who now own a greater share of the business. Smead and others think that Berkshire CEO Buffett is thrilled with this strategy.
Berkshire owns the nearly 20% common equity stake, holds warrants to buy 83.9 million Occidental shares at $59.62 and owns $10 billion of 8% preferred stock.
Looking ahead, Occidental will focus more on returning cash to shareholders than in paying down debt. That may include a higher dividend, which now is low at 52 cents annually for a yield of less than 1%. Most energy companies are returning considerably more cash to holders than Occidental.
In 2023, Occidental may be able to start paying down the high-rate Berkshire preferred. Under a formula, the company must start paying off the preferred if it returns more than $4 a share to its common holders in a given year.
Investors will be interested to hear from Occidental CEO Vicki Hollub on the company's conference call Wednesday morning for more on capital allocation, dividends, debt reduction, energy output and any clue about Berkshire's intentions. Some think Buffett may want to buy the rest of Occidental after rapidly increasing Berkshire's stake in recent months. Berkshire couldn't be reached for immediate comment.
Smead thinks that Occidental stock, which has doubled this year and is the top performer in the S&P 500, still looks appealing. It now trades for just six times earnings. 'It's demonstratively cheap relative to anything else you can do with capital." He values it at around $100 a share and think Buffett might be willing to pay $90 a share for it.
Occidental is a big energy producer in the U.S., getting about 80% of its more than a million barrels of daily energy output domestically. And Buffett loves American companies.